Rising U.S. bond yields pose risks to greenback
By Karen Brettell
NEW YORK, Oct 18 (Reuters) - Higher U.S. Treasury yields
have been cited as a factor supporting the greenback in recent
months. In the longer term, however, some analysts see rising
interest rates and mounting debt weighing on the dollar.
Federal Reserve interest rate increases and increasing
supply last week helped send benchmark 10-year bond yields to
Day to day, higher yields are cited as boosting the U.S.
dollar as capital flows into the country to seek out the higher
rates. But that correlation does not hold up in the longer term,
with higher yields instead being a drain on the currency.
“History shows that if we are still in this upward-moving
yield environment, that could continue to have a negative
feedback loop into the dollar,” said Tom Fitzpatrick, chief
technical strategist at Citigroup in New York.
The dollar index is down around 8 percent from a
14-year high in January 2017, and has climbed off three-year
lows set in February.
With the Fed expected to continue raising rates and the
United States projected to almost double its debt load held by
the public to $29 trillion in the coming decade from $16
trillion today, further weakness in bonds and the greenback is
In the past 30 years or so, the dollar has almost always
weakened when there have been major sell-offs in fixed income.
This includes in 1987, in 1994 and from 2004 to 2006, when in
each case the bond market weakened as the Fed raised rates.
The “taper tantrum” of 2013, when the Fed said it would
reduce bond purchases, also sent yields higher and hurt the
dollar, while yield increases on Fed rate hikes since late 2016
have weighed on the greenback.
An exception was from 1998-2000, when the United States had
a fiscal surplus, leading to expectations of debt paydowns, and
immediately after the introduction of the euro.
Conventional wisdom says that U.S. monetary tightening
automatically produces a stronger dollar, but in fact Fed rate
hikes are usually associated with dollar weakness, said Anatole
Kaletsky, chief economist and founding partner at Gavekal in
“Periods when the U.S. interest rate is going up, when the
Fed is tightening, are almost by definition periods when the
expected rate of return on capital in the U.S. is going down
relative to the rest of the world - and that means long-term
capital will flow out of the dollar," Kaletsky said.
Indeed, U.S. flow of funds data show that foreign purchases
of Treasuries often decline as yields increase.
The greenback was bolstered at the outset of quantitative
easing as the United States took the first steps toward
repairing its economy after the financial crisis. As other
regions such as the Eurozone get closer to rate increases, the
relative opportunities may shift in Europe’s favor.
Still, not all analysts view Fed rate rises as negative for
the greenback, and see dollar strength as having further room to
"To me the game changer is when the U.S. economy starts to
soften and the Fed has to think about cutting rates," said Win
Thin, global head of currency strategy at Brown Brothers
Harriman in New York.
A Reuters poll of currency strategists earlier this month
found that it could be another six months before the dominant
dollar strength trade is swept aside.
Worsening deficits and higher debt needs also make
investment in the United States less attractive even as economic
growth is solid, adding to pressure for higher yields.
The U.S. current account deficit reached 2.5 percent of
gross domestic product in the first quarter, a level at which
typically “the dollar starts to respond negatively,” said Bilal
Hafeez, global head of G10 foreign exchange strategy at Nomura
Further dollar weakness would fit with the longer-term trend
that has been in place since the end of the Bretton Woods system
It is also in line with some beliefs that the United States
is at the end of a 30-year bull run for bonds, with yields
recently having broken out of their long-term downtrend.
Assuming that the greenback reached an interim peak last
year, it now faces an additional five or six years of weakness,
based on its long-term bear trend, said Citi's Fitzpatrick.
“What we’re seeing here is not an episodic moment of dollar
weakness but in our view more likely an extended multiyear
period that is going to see the dollar significantly lower than
where it is today,” he said.
Hafeez sees the euro gaining against the greenback to around
the $1.40 area against the euro in the coming years, from $1.15
now, while Kaletsky sees a decline to around $1.30-$1.35.
Fitzpatrick sees a more bearish picture, with a decline to the
$1.80 area by 2024.
(Reporting by Karen Brettell; editing by Jonathan Oatis)
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